Why Our Stock Market Timing Model Is About To Trigger A “Sell” Signal
On January 27, I said it was not yet time to sell stocks, but the technical situation has deteriorated quite rapidly since then.
Yesterday (an FOMC day), stocks saw heavy volume selling action that produced another “distribution day” (a decline on increasing volume) in both the S&P 500 and NASDAQ Composite.
In a healthy market, a few days of institutional selling over a 3 to 4-week period is normal and can typically be absorbed by demand.
However, when the running count of distribution days reaches five or more, it nearly always signals a substantial correction is just around the corner.
The 3-Part Test
There are three main components that determine the mode of my broad market timing model, which determines whether I focus on the long or short side of the market, and how aggressively to do so. Right now, only one of those three tests is (barely) holding up.
1.) Volume Pattern Of Broad Market
In the NASDAQ, yesterday was the seventh day of higher volume selling in recent weeks. As such, the volume pattern portion of my broad market timing model is now flashing a clear “sell” signal.
2.) Broad Market Trend
In my January 27 blog post, I also mentioned one positive element of current market conditions was that both the NASDAQ and small-cap Russell 2000 were still holding above key support of their 50-day moving averages. But that is no longer the case.
With all broad-based indexes now below their respective 50-day moving averages, the trend component of the timing model has shifted to a “sell” signal as well (though I would like to give it to the end of the week to see if the NASDAQ can bounce back).
3.) Performance Of Leadership Stocks
The third and final component of our timing model, the performance of leadership stocks, is the only part of the model that is preventing the current “neutral” mode from officially shifting to “sell” mode (click here to see the five modes). Still, even this portion is barely holding on.
NASDAQ 4000 – Coming Soon?
Taking an updated look at the daily chart of the NASDAQ (below), notice the tech-heavy index reversed lower after running into new resistance of its 50-day moving average yesterday (January 29). The index also closed near its intraday low, near the intraday low of January 27 (near-term support).
If the price action follows through to the downside today (January 30), then bearish short-term momentum will likely take the index down to the 4,000 area (support of the December 2013 lows). However, a false move lower in the first hour of trading that subsequently reverses above the previous day’s high could lead to a short-term bounce:
Although my swing trading newsletter is not yet in full “sell” mode, I have been laying low (in “neutral” mode) this week. But as a bonus, a positive earnings report from Facebook ($FB) has currently launched our existing long position to an unrealized gain of approximately 27% since our December 2 buy entry.
The long side of the stock market is all about low volatility and steady/reliable price action. However, current conditions are quite volatile.
Therefore, even if I spot new bullish setups on the long side of the market (such as $AMBA or $AL), the stock market is simply too unstable right now to add new exposure with confidence.
Trade What You See, Not What You Think!
Obviously, there are quite a few scenarios that could play out from here, and that is why we always shy away from predicting market action and worrying about where the major averages will go.
Consistently profitable trading is all about reacting to price action, not predicting it. I can discuss different possibilities and have a plan in place, but I still have no clue what will happen tomorrow.
If my timing model shifts into full “sell” signal, I will then start focusing on short selling stocks and ETFs with the most relative weakness.
Nevertheless, with the market already down sharply in such a short period of time, there are simply no low-risk short entries at the moment.
Chasing on the short side can be just as bad or worse than chasing longs. If you have ever been caught in a short squeeze, you know that the price action can explode higher for several days before taking a break.
With the very real possibility of a significant correction just around the corner, this is a great time to review my preferred strategy for entering new trades on the short side. Upon doing so, you will surely see the importance of maintaining discipline and patience right now.
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